Speech by SEC Commissioner:
Continuing to Improve the Quality, Transparency, and Reliability of Credit Ratings

by

Commissioner Luis A. Aguilar

U.S. Securities and Exchange Commission

SEC Open Meeting
Washington, D.C.
May 18, 2011

Today’s proposal is designed to implement provisions of the Dodd-Frank Act regarding “Improvements to the Regulation of Credit Rating Agencies.”1 It also continues our own efforts to strengthen our oversight of nationally recognized statistical rating organizations (NRSROs), to improve the quality of their ratings, to reduce the conflicts of interest in their business models, and to increase the transparency of ratings methodologies and the performance of ratings over time.2

The financial crisis that still affects the lives of many Americans exposed serious shortcomings in the performance of NRSRO ratings. In response, Congress included provisions in the Dodd-Frank Act to strengthen the regulation of NRSROs and to provide the users of credit ratings with additional disclosures.

Together, the many components of today’s proposal address a broad array of NRSRO conduct, including:

a requirement that policies and procedures for ratings methodologies be documented and that they be approved by the NRSRO’s board;

the requirement for an annual report to the Commission regarding the effectiveness of internal controls over the ratings process;

enhanced disclosure to ratings users about the methodology and assumptions underlying a rating, the quantitative factors affecting the rating’s reliability, and the findings and conclusions of any third-party hired to provide due diligence regarding an asset-backed security;

the explicit separation of sales and marketing personnel from the production of credit ratings;

the requirement that NRSROs review ratings activity involving an employee who subsequently leaves to work for the issuer, underwriter, or sponsor of the rated security and disclose the results of this review; and

enhanced public disclosure of the performance of ratings.

I want to highlight the changes to the disclosure of historical ratings performance. The existing performance disclosure rules have been criticized by the GAO for resulting in data of “limited usefulness.”3

The requirements being proposed are designed to enhance the usefulness and comparability of performance disclosures. First, under today’s proposal, there would be greater transparency into the historical performance of an NRSRO’s individual credit ratings. The publicly available information about individual ratings would be improved by requiring disclosure as to a larger set of ratings and by requiring more comprehensive and standardized disclosure about each rating.4 And second, our proposal would make it easier to compare the statistics that NRSROs must disclose each year to describe the historical performance of all of their credit ratings, grouped by the type of instrument (e.g., corporate debt), initial rating (e.g., AAA), and period of time (e.g., 1, 3, and 10 years).5

By standardizing the disclosure of historical performance, by individual rating and by category of rating, our proposal would make it easier for ratings users and others, such as academics, to make meaningful comparisons of the quality of ratings by different NRSROs. This improved transparency will bring greater accountability. And holding NRSROs publicly accountable for their ratings quality would be expected to increase their incentives to ensure that their ratings are well-founded in careful analysis.

As to these and the other aspects of today’s proposal, I look forward to receiving comments on whether the proposed rules will meet our objective of strengthening the objectivity, accuracy, and usefulness of credit ratings, as well as any ways in which the proposal could be improved.

In closing, I join my colleagues in thanking the staff for their work on this set of rules, and I support today’s proposal.

3See U.S Gov’t Accountability Office, GAO-10-782, Securities and Exchange Commission: Action Needed to Improve Rating Agency Registration Program and Performance-Related Disclosures at 24 (2010) (finding that ratings history data sets do not contain enough information to construct comparable performance statistics and that NSRSOs have used varied methodologies to calculate performance statistics, limiting their comparability), available at http://www.gao.gov/new.items/d10782.pdf.

4 Currently, under Exchange Act Rule 17g-2(d)(2), an NRSRO must make publicly available on its website records showing all ratings actions as to a random 10% sample of the outstanding issuer-paid credit ratings for each class of credit rating for which the NRSRO is registered and for which it has issued 500 or more outstanding issuer-paid credit ratings. Also, under current Exchange Act Rule 17g-2(d)(3), an NRSRO must make publicly available on its website records showing all ratings actions as to 100% of credit ratings that were initially determined on or after June 26, 2007, with a 12 month lag time for disclosure of issuer-paid ratings and a 24 month lag time for disclosure of ratings that were not issuer-paid.

Under today’s proposal, the 10% disclosure requirement would be discontinued, and the 100% disclosure requirement, which would be moved to Rule 17g-7(b), would be expanded by (1) including all credit ratings that were outstanding as of June 26, 2007 (as compared to those initially determined on or after that date), (2) specifying additional information to be disclosed about the type of instrument being rated, the identity of the obligor or issuer, and the nature of the ratings action, and (3) requiring that the ratings history for an instrument be made public for at least 20 years after the NRSRO’s rating of the instrument is withdrawn. The lag times for issuer-paid and non-issuer-paid ratings remain the same.

5 Today’s release proposes amendments to Instruction H to Form NRSRO, which governs the calculation and presentation of performance measurement statistics for various categories of credit ratings over short-term, mid-term, and long-term periods. Each NRSRO must annually disclose these performance statistics in Exhibit 1 to Form NRSRO. As the release notes, the current instructions do not prescribe the methodology an NRSRO must use to calculate and present performance measurement statistics, and NRSROs have used different techniques to produce these statistics, leading to widely inconsistent presentation of the statistics. Today’s proposal would prescribe a uniform methodology for calculating and presenting these performance statistics.